Question

**Question 3 **

An investor believes that there will be a big jump in

a stock price, but is uncertain as to the direction. Identify **five** different strategies the investor can follow. Compare and explain the **differences** among them.

**Question 4 (10 marks)**

An investor has a **bearish** view of the stock, which he would like to take advantage of by constructing an option 'spread' strategy. Your goal is to **maximize the initial cash inflow** using this strategy. Suppose there exists the following options on the same underlying share of the stock. The share is currently trading in the market at $40.

(a) Which options would you use for your spread strategy? Explain your answer.

(b) Construct a payoff table for your option strategy. Show the payoff for individual options you use and the total payoff of the spread.

(c) Draw a payoff diagram for your strategy, show the maximum and minimum level of payoff and strike price(s).

**Question 5**

A stock price follows geometric Brownian motion with an expected return (µ) of 15% and a volatility (σ) of 30%. The current price is $45. (Tip: make use of the ln(S_{T}) distribution)

(a) What is the probability that a European call option on the stock with an exercise price of $50 and a maturity date in six months will be exercised?

(b) What is the probability that a European put option on the stock with the same exercise price and maturity will be exercised?

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